Solving SEK's summer sell-off – Deutsche Bank

Oliver Harvey, Macro strategist at Deutsche Bank, notes that the Swedish krona has been one of the worst performing currencies over the summer with the broad trade weighted down nearly 4% since May.

Key Quotes

“Data has turned lower but fundamentals still strong

Data has weakened in Sweden over recent months, with economic surprises deteriorating to near extreme lows. Unrealistic expectations are more culpable than weak numbers, however. The manufacturing confidence survey has fallen since the start of the year, but this was from record highs and Eurozone indicators like the IFO suggest now suggest upside. On the domestic front, demand continues to hold up well as shown by robust retail sales, and unemployment has made new cycle lows. In short, there doesn’t seem much to worry about on the growth front.

Positioning was stretched but now much lighter

Stokkie became a consensus trade late last year as investors were beguiled by its attractive valuation and rates repricing story. Our CORAX positioning report showed a big build up of longs by March. Since then, there has been a huge unwind, with hedge fund investors now net short krona on a 12 month basis and asset managers’ longs down by more than half. Krona selling over the summer has been particularly aggressive.

SEK hurt in carry environment but policy drivers still strong

With the Fed on permahold the summer months have not been conducive to low yielders. As well as negative rates, high inflation numbers leave the krona with the second worst real yields in G10. That explains SEK underperformance during the recent bout of dollar weakness. Going forward, monetary policy drivers should become more favorable.

The Riksbank’s next meeting is on the 7th of September, the day before Draghi. Our economists expect a six month extension to the ECB’s QE program, but the case for more Riksbank easing is far from clear. The krona is still slightly cheap to July forecasts, but inflation is bang in line and, as mentioned above, growth is still strong. The market isn’t pricing much in the way of rate cuts, but if the Riksbank fails to extend its QE program the balance sheet will stop expanding by the end of the year. The relative size of ECB/Riksbank balance sheets has been a good guide to EUR/SEK and already shows it as expensive.

In sum, SEK longs have been painful to hold over the summer months, but we don’t think circumstances justify throwing in the towel. The krona remains one of the most undervalued currencies in the world and at some point the Riksbank will have to reckon with inflation risks. As well as the euro, buying the krona against GBP offers cheapening to express a bearish sterling view.”